The end of June saw the introduction of the Corporate Insolvency & Governance Act 2020. Described as the biggest shakeup to the UK’s insolvency framework in twenty years, the overriding objective of the new legislation is to provide businesses with the breathing space they need to continue trading during the COVID-19 pandemic.
The Act as a whole has been analysed previously (at Bill stage) by Ashfords’ Restructuring & Insolvency Team, and our commentary in this regard can be found at New measures proposed by the Corporate Insolvency and Governance Bill; Corporate Insolvency and Governance Bill; Wrongful trading. In this article, Laura Reeve (Associate) and Stephen Homer (Partner) in our Construction & Infrastructure Team focus specifically on the implications for construction contracts.
Section 14 of the new Act is the key provision relevant to how construction contracts will be interpreted moving forward. Unlike some other aspects of the Act which comprise temporary modifications designed to ease the burdens of the current global crisis, the changes introduced by Section 14 are permanent.
1. When does the legislation apply?
The changes apply “where a company becomes subject to a relevant insolvency procedure”. The term ‘relevant insolvency procedure’ is defined in the Act and includes two new processes introduced by the legislation (namely, a pre-insolvency Moratorium and a new Restructuring Plan).
In a construction context, the term ‘company’ will in practice refer to the entity receiving the benefit of the works under the contract in question. So in the case of a main contract, the ‘company’ will be the Employer, while under a sub-contract it will be the Contractor.
In essence, therefore, the legislation becomes directly relevant under a construction contract where:
- in the case of a main contract, the Employer becomes subject to a ‘relevant insolvency procedure’; or
- in the case of a sub-contract, the Contractor becomes subject to a relevant insolvency procedure.
In the remainder of this article, we refer to the party that has become subject to a relevant insolvency procedure as the “Client” and the counter-party as the “Supplier”.
2. What does the legislation do?
As a result of the new Act, where a Client becomes subject to a relevant insolvency procedure, the Supplier will be legally unable to:
- terminate the contract; or
- do “any other thing”,
otherwise permitted by the contract terms because of the Client’s insolvency status. Effectively, any provision in the contract enabling the Supplier to take action in response to the Client becoming subject to a relevant insolvency procedure will no longer have any effect under the new legislation. This will include, for example, clause 8.10 of the JCT main contract suite (Termination for insolvency of the Employer).
Additionally, where the Supplier is entitled to terminate the contract because of an event occurring, and the corresponding right of termination arising, before the start of the Client’s “insolvency period” (again defined in the Act), that entitlement may not be exercised during the insolvency period.
Finally, the Supplier is prohibited from making it a condition of continuing with performance of its contractual obligations (or doing anything which has the effect of making it a condition of such continuation) that any outstanding charges relating to work carried out before the Client was made subject to a relevant insolvency procedure are paid.
The rationale driving all of these changes is to prevent attempts to rescue the Client’s business from being jeopardised by Suppliers stopping, or threatening to stop, performance of their contractual obligations. It is worth noting in particular that, where a Supplier is unable to terminate due to the application of the new provisions, and is contractually obliged to supply after the commencement of the relevant insolvency procedure, the Client’s contractual obligations to pay for that supply will be treated as an expense of the procedure. Essentially this is intended to allow a business to trade or maintain its key supply relationships on a ‘pay as you go’ basis without being held to ransom over arrears, in a bid to facilitate the survival of the insolvent entity.
3. Are there any exemptions?
Yes. Firstly, a Supplier can still exercise an insolvency-related right of termination if:
- the Provider (or its administrator, liquidator etc.) consents to the termination; or
- a Court is satisfied that continuation of the contract would cause the Supplier hardship and grants permission for the termination of the contract.
The Act does not expand upon what is meant by “hardship” and this will no doubt prove a matter of contention that the Courts will need to provide further guidance on.
Secondly, there is a temporary exemption for ‘small’ Suppliers until 30 September 2020. A Supplier is classed as ‘small’ if at least two of the following conditions are met in relation to its most recent financial year:
Condition 1: the Supplier’s turnover was not more than £10.2 million;
Condition 2: the Supplier’s balance sheet total was not more than £5.1 million;
Condition 3: the number of the Supplier’s employees was not more than 50.
The Act then provides further elaboration of how these are calculated, and also imposes a different test for Suppliers in their first year of trading.
4. What about the statutory right to suspend?
The new legislation raises important questions regarding the continuing ambit and validity of the right of suspension under section 112 of the Housing Grants, Construction & Regeneration Act 1996 (the “Construction Act”). That section provides that a Supplier under a construction contract can suspend performance of its contractual obligations upon giving seven days’ written notice if the Client fails to pay a sum due to the Supplier by the ‘final date for payment’. However, the new prohibition on a Supplier “[doing] anything” which has the effect of making continuing performance conditional upon outstanding charges being paid would appear to conflict with this right of suspension (at least for the duration of the insolvency period).
We have of course very recently seen matters proceed all the way to the Supreme Court to clarify an apparent discrepancy between the Construction Act and insolvency legislation (in the case of Bresco Electrical Services Ltd v Michael J Lonsdale (Electrical) Ltd ). No sooner has that decision been handed down, it appears we yet again have fertile ground for dispute over how the Construction Act can be reconciled with the new insolvency regime. In the meantime, the uncertainty surrounding this point, combined with the significance of the legislative changes as a whole, could well see Suppliers exercising their rights of suspension (or indeed termination) earlier than perhaps they ordinarily would have done in the past, for fear of becoming tied into continuing performance once the Client becomes subject to an insolvency procedure. Smaller Suppliers in particular will be rightly concerned about the costs of having to make an application for relief under the hardship exemption, which may prompt the earlier triggering of contractual rights and remedies before a relevant insolvency procedure commences and the legislation bites.